1. Lonni Steven Wilson, Medaille College chapter 15 Spending Earnings

2. Key Chapter Objectives Describe different types of dividend policies and how they are used. Describe how a business utilizes retained earnings. Understand how mergers and acquisitions are a way for a sport business to expand. Describe the legal concerns associated with mergers and acquisitions.

3. Key Terms dividend payments—Payments made out of earnings, in the form of either cash or stock, to a business’ owners or shareholders (Brigham & Ehrhardt, 2005). distributions—Similar to a dividend but paid out of sources other than current or accumulated retained earnings. retained earnings—Company keeps earnings for capital investment and forgoes paying shareholders.

4. Decisions About Using Earnings The right decision about using earnings selects the option that will produce the greatest value to the Ownership or to the Shareholders (in the case of a publicly owned company)

5. Methods of Using Earnings In general, sport businesses have three choices for using earnings: 1.Pay dividends to shareholders, if it is a for-profit business 2.Retain earnings for reinvestment in the business. 3.Reinvest in other firms by purchasing a percentage or acquiring other firms outright.

6. Views on Making Dividend Payments The first method of dealing with earnings is to pay dividends. Three views exist on how to pay dividends: Pay the highest possible dividend. Make a middle-ground dividend payment, somewhere between high and low, that will satisfy most shareholders. Pay the lowest possible dividend. (Brealey, Myers, & Marcus, 2004)

7. Buying Back Stock Companies may opt to buy back stock as a means of repaying investors (i.e., instead of continuing to pay dividends). Results The number of shares outstanding decreases The book value per share increases Reasons a company may buy back stock Distribution of earnings (instead of issuing a dividend) Change capital structure

8. Paying Stock Dividends Companies may “pay” stock dividends in lieu of cash. Potential negative results—A dividend paid in stock can have a dilutive effect on share price. Potential positive results—Stockholders may save money on taxes. (continued)

9. Paying Stock Dividends (continued) Capital gains versus income tax: how shareholders may save Cash dividend payments are taxed as income for shareholders. Money earned from the sale of stock is taxed as capital gains. If stockholders sell the new stock within one year of owning it, they are taxed 28% (as of January 2006) on their gains. However, if stockholders sell the new stock after more than a year of ownership, they are taxed only 15% on their gains. On the basis of taxation policy, many stockholders would prefer the repurchase of stock over dividend payments (Brealey, Myers, & Marcus, 2004).

10. Retaining Earnings The second method of dealing with earnings is to retain earnings. Dividend payments cannot exceed retained earnings on a business’ balance sheet (impairment of capital rule). Considerations in the amount of retained earnings A business’ capital structure, capital budgeting decisions, and dividend policy A business’ size Target capital structure (proportion of debt to equity) Managerial control

11. Reinvesting in Other Firms The third method of dealing with earnings is to reinvest in other businesses, which takes one of two forms: Mergers –A merger is the combining of two or more businesses into one. –One business blends its business with the acquired business. Acquisitions –In an acquisition, the acquiring company maintains control over the acquired company and serves in a dominant position over it. –The two businesses remain their own distinct companies.

12. Types of Mergers Horizontal: Two companies in the same line of business are joined. Vertical: A buyer expands operations forward toward the final customer or backward toward the source of raw materials. –Upstream markets (closer to raw materials) –Downstream markets (further down in the production process; closer to customer) Conglomerate: Companies in unrelated lines of business come together.

13. An Example of a Sport Company Acquisition An excellent example of a company’s acquiring another business in an attempt to increase its own value is News Corporation, owned by Rupert Murdoch. News Corporation operates television networks such as the Fox Network, Fox Sports, and BSkyB. As part of an overall business strategy, News Corporation acquired the Los Angeles Dodgers for $311 million in 1998 (Chass, 1998). One reason for the purchase was to provide broadcast content for the company’s television networks. (continued)

14. An Example of a Sport Company Acquisition (continued) Therefore, although the Dodgers may not have been a company that provided large profits, Murdoch’s goal was to use them to help his other business ventures such as television and radio broadcasting. Interestingly, Murdoch’s goal of using the Los Angeles Dodgers to generate profits for his other holdings in broadcasting failed to materialize. In 2004, Murdoch sold the Dodgers to real estate mogul Frank McCourt for $430 million. (Frew, 2004)

15. Questions for In-Class Discussion 1.Is consolidation in the sport industry good? 2.Do you think it would be worthwhile to create another football league similar to the United States Football League or the XFL? Would another baseball, hockey, or basketball league be a better investment? 3.If you could make 10% from a government bond or 10% from investing in a professional sports team, which one would you invest in and why? 4.If you had this responsibility within a corporation, under what circumstances would you make a decision to reinvest versus issuing a dividend?